Becoming a 401(k) Millionaire

Last September, one of the largest providers of 401(k) plans (Fidelity) reported that only 1% of its active retirement accounts held a balance of $1 million or more. One may think that becoming a 401(k) millionaire is only possible for people earning at least six figures, but this is definitely not the case.

For example, a 25-year-old making $45,000 who saves 7% per year and earns a 7% rate of return will have an account balance over $1 million at age 65, assuming an annual 3% salary increase. If our hypothetical participant were to start ten years later, even with an inflated salary, the account balance would be just over $600,000. To get to $1 million, he or she would have to defer about 11.5% of salary.

Clearly, the first step to becoming a 401(k) millionaire is to start early. To put it simply, the more time your money has to compound, the more miraculous will be the results of what Albert Einstein deemed “the miracle of compound interest.”

The second step is to save meaningfully and consistently. To arrive at a meaningful percentage, start with whatever the plan sponsor is matching or automatically contributing and ask yourself how much further you can realistically increase it. As your earnings increase, your savings should increase as well. A raise should be viewed as an opportunity to increase your percentage deferral rate. A good way to think about is “paying yourself first.”

The third step is to choose an appropriate asset allocation and stay with it no matter what happens in the financial markets. For most participants, either an asset allocation model or a target date fund is an excellent choice, as it removes the temptation to tinker with individual funds, which often enough, ends in tears. Needless to say, only low-cost and highly-diversified funds should be utilized.

Finally and perhaps most importantly, resist all temptation to invade your account, whether through loans or early distributions. If we can be of service to you in helping you set a new deferral rate or reviewing your current investment choices, please do not hesitate to email us at advisors@clarityca.com.